Bond Financing for Educational Institutions

Schools, colleges and universities and other educational organizations that

have qualified as organizations described in Section 501(c)(3) of the Internal

Revenue Code are eligible to use tax-exempt bonds to finance capital and

operating costs. Usually, exempt educational institutions look to contributions

from alumni and other donors to finance capital projects such as libraries,

dormitories, classrooms, and other major projects. A carefully designed capital

campaign can, however, take advantage of both low-interest-rate, tax-exempt bond

financing as well as the donor interest created by new capital projects to

enhance the financial stability of the institution.

An institution is eligible for tax-exempt bond financing if the institution

does not have readily available dedicated assets available to finance the

project. An exception is generally made for the endowment held by such an

institution even if the endowment could be depleted to provide financing for the

project. In particular, the endowment is permitted to act as security for bond

financing although that arrangement may influence the rate of return on certain

assets in the endowment. If the borrower receives a restricted donation that

must, by its terms, be used to finance the capital project, those funds must be

contributed to the bond fund and used to retire outstanding bonds as quickly as

possible. Thus, it is generally the case that an educational institution that

issues tax-exempt bonds for a capital Project will contain a provision requiring

the redemption of the bonds with the proceeds of any gift that is restricted to

financing that project.

Restricted gifts occur when the donor wants to assure that the gift is used

for an appropriate purpose. Frequently, the donor is encouraged to restrict the

use of the proceeds of the gift by the creation of naming opportunities through

which the donor receives recognition for the contribution. If, however, the

capital campaign is structured in a way to provide recognition for the donation

while eliminating the direct connection between the proceeds of the gift and the

project, the institution can increase the size of its endowment while at the

same time taking advantage of the low interest cost tax exempt financing with

respect to the project.

There are three requirements in order to achieve this result. First, the

institution must be able to establish that it needs to borrow the proceeds of a

tax-exempt bond in order to finance the...